Operational Techniques for Managing Transaction Exposure

Operational strategies having the virtue of offsetting existing foreign currency exposure can also mitigate transaction exposure. These strategies include −

●      Risk Shifting − The most obvious way is to not have any exposure. By invoicing all parts of the transactions in the home currency, the firm can avoid transaction exposure completely. However, it is not possible in all cases.

●      Currency risk sharing − The two parties can share the transaction risk. As the short-term transaction exposure is nearly a zero sum game, one party loses and the other party gains%

●      Leading and Lagging − It involves playing with the time of the foreign currency cash flows. When the foreign currency (in which the nominal contract is denominated) is appreciating, pay off the liabilities early and collect the receivables later. The first is known as leading and the latter is called lagging.

●      Reinvoicing Centers − A reinvoicing center is a third-party corporate subsidiary that uses to manage one location for all transaction exposure from intra-company trade. In a reinvoicing center, the transactions are carried out in the domestic currency, and hence, the reinvoicing center suffers from all the transaction exposure.

Reinvoicing centers have three main advantages −

●      The centralized management gains of transaction exposures remain within company sales.

●      Foreign currency prices can be adjusted in advance to assist foreign affiliates budgeting processes and improve intra affiliate cash flows, as intra-company accounts use domestic currency.

●      Reinvoicing centers (offshore, third country) qualify for local non-resident status and gain from the offered tax and currency market benefits.

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